Oil price shocks and stock markets: testing for non-linearity

This paper formally tests for non-linearity in the relationship between real oil prices and real stock returns for Canada, Germany, the UK, and the US, and also assesses whether there are significant differences in the impact of oil price shocks on the stock markets studied. The findings provide evidence of non-linearity when windows with a fixed number of observations are considered. The non-linear specification that seems to do the best job of summarizing such non-linearity is the scaled specification, which considers not just whether oil prices increase or decline (and by how much) but also the environment in which the movements take place, highlighting more specifically the importance of controlling for the time-varying conditional variability of oil price shocks. An oil shock in a stable price environment is likely to have larger consequences on stock returns than one in a volatile price environment. Moreover, we find negative responses of real stock returns to oil price shocks for all countries. These responses are generally statistically similar between the North American countries considered, and between the European countries studied, although statistically different between the two groups of countries.